In the past few months, ABB has been one engineering company that has generated tremendous enthusiasm on the Indian stocks markets. Apart from the superb financial performance of the company in FY04 (December ending), the fact that the parent has reinforced its thrust in considering the Indian arm as one of the major global outsourcing hubs seem to have led to this optimism for the stock. In this article, we will take a peep into the company's performance over the past few years and see where it is headed into the future.
ABB: The company
ABB India is a 52% subsidiary of ABB, Switzerland. The company has divided its operations into two focus areas - power technology (PT) and automation technology (AT). Under power technologies, the company supplies transmission and distribution (T&D) equipments to the power sector. ABB India is also the outsourcing agent for the parent company in the T&D segment. This segment contributes around 60% of the company's total revenues. In automation technologies, the company is into providing analytical solutions, industry solutions, robotics and control systems, and the segment contributes to the remaining 40% of revenues. During the period CY00 and CY04, ABB's sales and profits have grown at CAGR of 24% and 33% respectively.
Past performance: Good…
ABB has reported strong performances over the past few years and has managed to outperform its Indian PSU peer, Bhel (see adjoining chart). The company's growth has been led by its PT business where it has emerged as a major supplier of transmission and distribution (T&D) equipments to power sector utilities in the country. Now, with the government clearing the blueprint to add 100,000 MW of electricity generation capacity by 2012, the engineering sector is likely to be a major beneficiary as a large investment in the T&D business is also expected. As part of the government's APDRP (accelerated power development and reforms program) program, the states will have to unbundle the generation, transmission and distribution, and invest in T&D infrastructure. This will further augment the performance of the engineering sector in general and ABB in particular. At the end of calender year 2004, ABB had an order backlog of Rs 9.3 bn (around 67% of CY04 PT revenues) in the PT business and we expect this segment to be a growth driver for the company in the future.
…but, risks remain
While the past performance of ABB has been good, as indicated above, the growth of the industry (power) from where the company generates a significant chunk of its revenues is highly dependent on the government's reform measures. And herein lies the biggest risk to its growth going forward. As a matter of fact, in our recent interaction, ABB's management had indicated that the government's plans to add 100,000 MW of generation capacity by the year 2012 will not make much difference to the demand-supply mismatch that has long been prevailing in the Indian electricity sector. We need a radical approach to investments in the sector and a major chunk of funding needs to come from the public sector. The fact that China has added 30,000 MW in the year 2004 alone even when its has almost three times India's generation capacity should be a lesson for us if we wish to provide 'power for all'.
So, what to expect?
At the current price of Rs 1,280, the stock is trading at a price to earnings multiple of 35.2 times CY04 earnings and 2.4 times market-cap to sales. While we are positive about the long-term growth prospects of the company, the fact that current valuations are at the higher end of the spectrum and factor in the medium term growth prospects of the company should call for some caution from investors. Also, in our view, the order book position cannot rise at a much faster rate than what is executable and therefore, investors have to be realistic with respect to the order book growth. Unlike the past, most of the global engineering majors (upon reading their annual reports) are looking at India and China for growth opportunities, and competition, in this sense, is only going to increase.
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